Monday, December 27, 2010

Transcript: Outlook 2011

This week on Intelligent Investing, we're taking a look at the crystal ball and coming up with some predictions for 2011.

What's likely to move the real estate market next year? Find out from Boston Properties ( BXP - news - people ) Chairman Mort Zuckerman. What is to become of Wall Street in the age of reform? Jack Bogle takes a look at the market from 30,000 feet and more than half a century if investing. Plus, James Wolfensohn, former head of the World Bank, brings his unique perspective on the global economy and philanthropy.

John "Jack" Bogle On Fundamentals

Steve Forbes: Well, Jack, good to have you with us again. I have to ask you a question--I think I know the answer--in terms of what you see ahead for 2011, the next 12 months. Your time horizon seems to go beyond one year.

Jack Bogle: Yeah, nobody can predict. While the economy will probably stumble its way a little bit higher, I don't look for anything big on the economic front, any big gains. But we'll probably stumble through this recession and this slow growth that's following it. But in terms of the stock market, there's no point in predicting the stock market for a year because a stock market is based on two simple things. One is fundamentals, which I call investment return, Lord Keynes called it enterprise, and emotions, which he called speculation.

And emotions drive the stock market in the short run. And in the long run, it's all about fundamentals, the discounted value of the cash flow that our corporations generate over time, over a long period of time, intrinsic value, we call it.

So we can guess the intrinsic value on approval a little bit. GDP seems to grow at about the same rate as corporate earnings, so we can expect some growth in corporate earnings. We have a dividend yield to add to that, admittedly a very low dividend yield, around two percent. But I think the outlook for investment return is good for next year, but the outlook for speculative return, whether people will pay a lot more or a lot less for stocks at the end of the year is problematic. However, over the long run, it is investment return that drives the mare.

It is, as I say in the book, if there's a gap between perception and reality, it's only a matter of time, Steve, until reality takes over. And 10 years is not a lifetime, but you can look at 10 years where reality's going to be very important, and perception or speculation much less important. So if you look at it the next decade, which is, I don't go for shorter periods, we can see that 2% dividend yield. We can see maybe 6% earnings growth from corporate America. And that's an 8% return on stocks.

I think speculation will be a little less at the end of that period. That's a sheer guess. But maybe it will sheer a lower price earnings, multiple the price you pay for each dollar of earnings at the end of the period. So maybe the return on stocks will be about 7%. That's reasonable expectations for the coming decade, which means your money will double in a decade. So that's not bad. It's not what we're used to, but it's not bad.

Forbes: After the past 10 years, that sounds pretty good.

Bogle: Well, of course after the previous 20 years, the last 30 years look pretty normal. You know, it's all cycles back and forth. Emotion drove the market way upward in the first two decades, '80s and '90s, and then both fundamentals slowed down, and the emotional side--

Stocks can't sell at 40 times earnings for a decade, believe me. And they didn't. So that was the main reason that the returns were so poor. And compare that maybe 7% return on stocks with the return on bonds, which the hidden secret is that bond returns for the next decade are almost entirely shaped by today's interest rate.

So if we want to call that, using some government, some long, some short, some corporates, 3. 5% maybe. That means that bonds will give you about a 50% cumulative return over the coming decade. So those are the reasonable expectations. But reasonable expectations aren't always met, so I would tell investors be a little careful out there. There may be some things that are not very pleasant on the horizon, maybe a chance, I would say, 1 out of 15, 1 out of 10, 1 out of 20 that we have some really, really tough times coming. So maybe lean to the conservative side.

Mortimer Zuckerman On Real Estate

Forbes: So commercial real estate 2011, residential real estate 2011. Is it possible to have an outlook?

Mortimer Zuckerman: Yes, I mean, I think it will reflect primarily the macro economy. I mean, commercial real estate in particular frankly has done relatively well because the business community has known what to do. They know how to reduce their cost. Residential real estate, we talked about it before. I don't know where that bottom is. And we don't know where that bottom is. So the one thing we have to do is to get the economy working as well as we can.

And that is going to be a very difficult measure because politically we are deadlocked. So I frankly would have a stimulus program that in the short term and a major deficit reduction program in the intermediate and longer term. And they should be joined together so people do not feel as if we're going to spend our money and have nothing but huge debts to show for it. I'd have to do it as a package deal.